Electronic Grace Notice and Replacement Loans

Electronic Grace Notices

Pawn brokers and software developers are creating different ways to execute online transactions between pawn brokers and borrowers. Pawn brokers may now use third-party software applications or create their own program for executing such transactions. In any event, below is a process that pawn brokers should follow to validly deliver an electronic grace notice and/or execute an electronic replacement loan.

The law provides that a pawn broker may only deliver an electronic grace notice to a borrower’s electronic address when the borrower opts-into receiving an electronic grace notice and the borrower has responded to a communication from the pawn broker to the electronic address. (Cal. Fin. Code § 21201(d).) The process may look as follows. The pawn broker should have a section in its initial physical pawn contract that provides the borrower the option to opt-into an electronic grace notice delivered to the borrower’s electronic address. (Cal. Fin. Code § 21201(d).) “Electronic address” is not defined by the law and may be a borrower’s e-mail, cell-phone number, or user account in a software application. The pledgor must opt-into the electronic grace notification by indicating so on the contract, such as with their initial. (Id.) The borrower should then affix their electronic address on the contract so that the pawn broker may have the electronic address on file.

After learning the borrower’s electronic address, the pawn broker should deliver a communication to the electronic address. For example, the communication could state: “Thank you for using our pawn broker service. Please reply to this message with “VALID” to confirm your electronic address.” The borrower must then reply to the communication with the word “VALID.” After having received the communication from the borrower, the pawn broker may later deliver an electronic grace notice to the borrower’s electronic address. (Cal. Fin. Code § 21201(d).) Pawn brokers and their software applications of choice should not be automatically delivering electronic grace notices solely based on the borrower providing an electronic address. The borrower must respond to a pawn broker’s communication sent to their electronic address to validate the electronic address in order to receive an electronic grace notice.

The pawn broker’s grace notice must notify the borrower that their right of redemption is extended to ten (10) days after delivery of the grace notice and must include the following statement: “If the tenth day falls on a day when the pawnshop is closed, the time period is extended to the next day that the pawnshop is open.” (Cal. Fin. Code § 21201(d).)

A grace notice is only valid if it is delivered within 30 days after the expiration of the loan contract, but not prior to the expiration of the contract. (Cal. Fin. Code § 21201(d).) If a pawn broker fails to deliver the grace notice within the one-month period after the expiration of the loan, then the pawn broker is not allowed to charge interest and fees for any time after the one-month period has expired. (Id.)

The pawn broker should be aware that at any and all times throughout the life of the original pawn loan and any subsequent replacement loans, the borrower shall have the sole option to opt-out of receiving an electronic grace notice. (Id.) Accordingly, the pawn broker should disclose their procedures for opting-out of the electronic grace notice to the borrower on each one of its loans and subsequent communications to the borrower. Additionally, pawn brokers should be on notice that the Telephone Consumer Protection Act, 47 U.S.C. § 227 and others laws, require opt-in and opt-out disclosures and procedures, separate and distinct to those discussed herein. Lastly, a pawn broker should ensure to maintain record logs of each borrower’s opt-ins and opt-outs, among other recorded information, for three years from the date of receipt.

Electronic Replacement Loans

In a different situation, pawn brokers may use the convenience of electronic transactions to execute online replacement loans. Prior to the start of, or during, the 10-day grace period, a borrower may request, and a pawn broker may agree, to execute a replacement loan. (Cal. Fin. Code § 21201.5(c)(2).) The Cal. Financial Code allows for such online replacement loans and the process may look as follows. The borrower logs-into their account in the pawn broker’s software program and accesses their pledged item. The pledged item should only be accessible to the borrower through their account through a unique username and password. The borrower should then have the option to pay-off all outstanding charges from the prior loan then due, and execute a replacement loan. (Cal. Fin. Code § 21201.5(c)(2).) The borrower selects the option to proceed with executing the replacement loan and paying off all outstanding charges.

The borrower is then presented with a screen providing the borrower with all the necessary disclosures to execute an electronic signature. See more on electronic signature disclosures in the California Uniform Electronic Transactions Act, Cal. Civ. Code §§ 1633.1, et seq. The borrower then selects a box indicating that they agree to the disclosures. The borrower is then forced to view the replacement loan contract, both front and back, and affix their signature where indicated. The replacement loan contract should provide all the disclosures required by the Cal. Fin. Code §§ 21200, et seq., Truth in Lending Act (Regulation Z) 12 C.F.R §§ 226.17, et seq., and Military Lending Act 32 C.F.R. §§ 232.1, et seq. The electronic replacement loan contract should also require the borrower to initial next to each required disclosure for further acknowledgement of receipt of the disclosure.

Some specific disclosures to point out are included in the Cal. Fin. Code. The replacement loan contract should disclose the amount of the prior loan that is debited to the replacement loan. (Cal. Fin. Code § 21201.5(c)(3).) Also, every time a borrower executes a replacement loan, the borrower must “affirm that the current electronic address on file with the pawn broker is valid.” (Cal. Fin. Code § 21201(d).) Thus, the replacement loan should contain a checkbox section stating: “My current electronic address, [insert electronic address] on file with the pawn broker is valid” for the borrower to checkoff. (Cal. Fin. Code § 21201(d).)

After the borrower executes the contract, the pawn broker must mail or otherwise transmit a copy of the replacement loan to the borrower within five business days following the pawn broker’s receipt of payment. (Cal. Fin. Code § 21201.5(c)(7).) Once the pawn broker follows the steps mentioned above, and either mails the contract or transmits the contract to the borrower’s electronic address, such as an electronic PDF copy, then they have satisfied their requirements for executing an electronic replacement loan. There is currently no provision in California law authorizing a pawn broker to charge an extra fee or pass along a vendor’s fee for an online replacement loan. It is not recommended to charge an online transaction fee or pass along a software application vendors fee, as such fees have not been specifically authorized in California pawn law.

Electronic Replacement Loan Cautions

Pawn brokers should beware of a few possible oversights when executing an electronic replacement loan. One potential error is executing an electronic replacement loan after the expiration of the redemption period. A borrower’s pledged property becomes vested property of the pawn broker once the borrower defaults on the loan and fails to exercise their right of redemption. (Cal. Fin. Code § 21201(f).) After the pledged item becomes vested property of the pawn broker, the borrower and pawn broker are unable to revive the borrower’s interest in the pledged item and execute a replacement loan on such property. This is the case even if the borrower pays off all outstanding charges.

However, some software applications used to execute electronic replacement loans may still allow the borrower to access the pledged item, pay-off all outstanding charges, and execute a replacement loan, after the collateral has been foreclosed by the pawn broker. This is an unlawful loan and the pawn broker should avoid this practice by immediately removing the pledged item from the software application at the expiration of the applicable right of redemption period. However, the pawn broker may sell the item back to the borrower, tax free, by charging the principle plus interest and fees due to date, or by charging tax on the item but not outstanding charges.

A second potential error is charging the borrower fees for using a software application to execute an electronic replacement loan. Although a pawn broker may be able to charge the borrower a surcharge for the use of credit card, depending on how the charge is presented, the pawn broker should refrain from such charge considering the gray area surrounding the law. (Italian Colros Restaurant v. Becerra (2018) 878 F.3d1165.) Additionally, the pawn broker is not entitled to charge and pass along other fees not authorized by law to the borrower, such as a fee for delivering a copy of the replacement loan to the borrower, the electronic signing of the replacement loan, the borrower’s selection of a PDF copy of a replacement loan, etc.

Third, a pawn broker and borrower may agree to enter into a replacement loan prior to the buyer’s default. (Cal. Fin. Code § 21201.5(a).) In such a case, the pawnbroker must remember that the replacement loan will not take effect until the expiration of the original loan. (Id.) Accordingly, even if the agreement is made in the final month of the original loan, the pawn broker cannot charge interest and fees for the replacement loan, until after the expiration of the original loan.

Fourth, pawn brokers should not confuse replacement loans with extensions. A replacement loan may be agreed to prior to the expiration of an original contract, and any extension thereof, or during the redemption period. (Cal. Fin. Conde § 21201.5(a),(b).) The extension is an agreement between the pawn broker and the borrower, providing the borrower additional time, not included in the original loan agreement, free of interest and fees, to payoff outstanding charges and fees. The extension does not operate as a replacement loan and should not be treated as such.

Lastly, it is important to emphasize that compliance with California law to execute an electronic replacement loan does not mean compliance with Federal lending laws such as the Truth in Lending Act (Regulation Z) 12 C.F.R §§ 226.17, et seq., Military Lending Act 32 C.F.R. §§ 232.1, et seq., and Bank Secrecy Act, 31 U.S.C. §§ 5311, et seq., among others. Pawn brokers must comply with both California and Federal law when executing an electronic replacement loan. Due to the unique disclosure provisions of the Military Lending Act, including oral disclosures, it is not advisable to attempt online Military Lending Act replacement loans. It is recommended that your online replacement loan software and applications have a disclosure regarding Military Lending Act, whereby, if a person clicks that they are a covered person, the process stops. They are not allowed to do an online replacement loan, and they are directed to come into the store.